Publication 538 - Accounting Periods And Methods Page 15
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23Items Included in Inventory
Identifying Cost
Your inventory should include all of the following.
You can use any of the following methods to identify the
cost of items in inventory.
Merchandise or stock in trade.
Raw materials.
Specific Identification Method
Work in process.
Use the specific identification method when you can iden-
Finished products.
tify and match the actual cost to the items in inventory.
Supplies that physically become a part of the item in-
Use the FIFO or LIFO method, explained next, if:
tended for sale.
You cannot specifically identify items with their costs.
Merchandise. Include the following merchandise in in-
The same type of goods are intermingled in your in-
ventory.
ventory and they cannot be identified with specific in-
Purchased merchandise if title has passed to you,
voices.
even if the merchandise is in transit or you do not have
physical possession for another reason.
FIFO Method
Goods under contract for sale that you have not yet
segregated and applied to the contract.
The FIFO (first-in first-out) method assumes the items you
purchased or produced first are the first items you sold,
Goods out on consignment.
consumed, or otherwise disposed of. The items in inven-
Goods held for sale in display rooms, merchandise
tory at the end of the tax year are matched with the costs
mart rooms, or booths located away from your place
of similar items that you most recently purchased or pro-
of business.
duced.
C.O.D. mail sales. If you sell merchandise by mail and
LIFO Method
intend payment and delivery to happen at the same time,
title passes when payment is made. Include the merchan-
The LIFO (last-in first-out) method assumes the items of
dise in your closing inventory until the buyer pays for it.
inventory you purchased or produced last are the first
Containers. Containers such as kegs, bottles, and ca-
items you sold, consumed, or otherwise disposed of.
ses, regardless of whether they are on hand or returnable,
Items included in closing inventory are considered to be
should be included in inventory if title has not passed to
from the opening inventory in the order of acquisition and
the buyer of the contents. If title has passed to the buyer,
from those acquired during the tax year.
exclude the containers from inventory. Under certain cir-
LIFO rules. The rules for using the LIFO method are very
cumstances, some containers can be depreciated. See
complex. Two are discussed briefly here. For more infor-
Pub. 946.
mation on these and other LIFO rules, see sections 472
Merchandise not included. Do not include the fol-
through 474 of the Internal Revenue Code and the related
lowing merchandise in inventory.
income tax regulations.
Goods you have sold, but only if title has passed to
Dollar-value method. Under the dollar-value method
the buyer.
of pricing LIFO inventories, goods and products must be
grouped into one or more pools (classes of items), de-
Goods consigned to you.
pending on the kinds of goods or products in the invento-
Goods ordered for future delivery if you do not yet
ries. See Regulations section 1.472-8.
have title.
Simplified dollar-value method. Under this method,
Assets. Do not include the following in inventory.
you establish multiple inventory pools in general catego-
ries from appropriate government price indexes. You then
Land, buildings, and equipment used in your busi-
use changes in the price index to estimate the annual
ness.
change in price for inventory items in the pools.
Notes, accounts receivable, and similar assets.
An eligible small business (average annual gross re-
ceipts of $5 million or less for the 3 preceding tax years)
Real estate held for sale by a real estate dealer in the
can elect the simplified dollar-value LIFO method.
ordinary course of business.
For more information, see section 474. Taxpayers who
Supplies that do not physically become part of the
cannot use the method under section 474 should see
item intended for sale.
Regulations section 1.472-8(e)(3) for a similar simplified
Special rules apply to the cost of inventory or
dollar-value method.
property imported from a related person. See the
!
Adopting LIFO method. File Form 970, Application To
regulations under section 1059A of the Internal
CAUTION
Use LIFO Inventory Method, or a statement with all the in-
Revenue Code.
formation required on Form 970 to adopt the LIFO
Publication 538 (December 2016)
Page 15
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